Download International Securities Exchange

International Securities Exchange
March 2007
For the sake of simplicity, the examples that follow do not take into
consideration commissions and other transaction fees, tax
considerations, or margin requirements, which are factors that may
significantly affect the economic consequences of a given strategy.
An investor should review transaction costs, margin requirements and
tax considerations with a broker and tax advisor before entering
into any options strategy.
Options involve risk and are not suitable for everyone. Prior to buying
or selling an option, a person must receive a copy of
CHARACTERISTICS AND RISKS OF STANDARDIZED OPTIONS.
Copies have been provided for you today and may be obtained from
your broker, one of the exchanges or The Options Clearing
Corporation. A prospectus, which discusses the role of The Options
Clearing Corporation, is also available, without charge, upon request
at 1-888-OPTIONS or www.888options.com.
Any strategies discussed, including examples using actual securities
price data, are strictly for illustrative and educational purposes and
are not to be construed as an endorsement, recommendation or
solicitation to buy or sell securities.
1
CASH SETTLED ISE FX Options
TM
(Pending SEC approval)
• The World’s Most Innovative Exchange
• The World’s Most Dynamic Market
• Designed For The Savvy Investor
2
History of FX
• The Bretton Woods Agreement was initiated in 1944 in an effort to
keep cash from draining out of war-ravaged Europe. Currency
movements were limited to 1% against the U.S. Dollar, which was
fixed to the price of gold at 35 US Dollars an ounce. The modern era
of foreign exchange first emerged in 1971 with the collapse of the
Bretton Woods Agreement. The U.S. Dollar was no longer
convertible into gold and market forces were free to adjust foreign
exchange rates, signaling an increase in currency market volatility
and trading opportunities.
• The collapse in 1973 of the subsequent Smithsonian and European
Joint Float agreements signaled the true beginning of the freefloating currency exchange system that drives the markets today.
Starting in the 1980’s, computer technology extended the reach of
the exchange marketplace. Today, the values of the major world
currencies are independent of each other.
3
More history of FX
• 1978- Europe created the European
Monetary System to reduce its
dependence from the U.S.
• 1992- George Soros and other investors
outlasted the Bank of England and forced
the currency into a “free float”
• 1999- Europe launched the Euro currency
to free float creating one of the largest
traded currencies in the world
4
Fiat money
• Refers to money that is not backed by
reserves of another commodity
• The money itself is given value by
government fiat (Latin for "let it be done")
or decree, enforcing legal tender laws,
previously known as "forced tender",
whereby debtors are legally relieved of the
debt if they (offer to) pay it off in the
government's money
5
Fiat money
• Without anything backing a currency there is no
restraint on credit growth, this can be both good
and bad
• Initially, a rapid growth in the availability of credit
is often mistaken for economic growth, as
spending and business profits grow and
frequently there is a rapid growth in equity prices
• However, the economy may suffer periods of
contraction as too much credit can lead to boombust cycles, inflation and possibly recessions
6
What is a “Good” currency?
• A currency that creates confidence
• Retains value by maintaining purchasing
power
• Keeps intermediate and long term interest
rates at a level that sustains economic
growth because they factor in low
expectations of future inflation
7
What is FX?
• Foreign Exchange is a currency market
where the trading of one currency against
another takes place. It is often referred to
as Forex or FX.
• The foreign exchange market is the largest
most liquid and most influential market in
the world
8
FX Market
• Daily Turnover Estimated At $1.9 Trillion
• Primary Trading Centered Around New
York, London and Tokyo Business Hours
(Although trading is virtually continuous)
• Market Dominated By OTC Futures And
Forwards
• Largest Turnover EUR, GBP And JPY
9
What moves currency markets?
• If a country's economic outlook improves, there
will be a surge of interest and international
investors will move money into the economy and
thus drive up the value of its currency. Because
of this, currency traders pay close attention to
indicators that follow the health of an economy
10
What moves currency markets?
• Ultimately, it is supply and demand that
determines a currency value
11
Factors to consider when looking at FX
• Significant indicators that investors and traders
watch include GDP, interest rates, international
trade, and the unemployment rate
• A country's political outlook will also affect how
attractive it is to investors
• Inflationary expectations and each country’s
savings rate
• The amount of debt relative to the amount of
growth is also important for investors
12
Why Options? Why Bother?
Without options, these are all of the
available choices.
Long Stock
Short Stock
Treasury Bill
13
Why Options? Why Bother?
With options, these are some of the
available choices.
Long Call
Short Call
Long Put
Short Put
Long Straddle
Short Straddle
Long Strangle
Short Strangle
Long Call
Spread
Short Call
Spread
Long Put
Spread
Short Put
Spread
Ratio Call
Spread
Call Volatility
Spread
Long SplitStrike Synthetic
Put Volatility
Spread
14
Why Trade FX options?
• You can make a forecast on any of the SEC
approved currency pairs and place the
appropriate trade
• If you feel the U.S. economy is strong and will
strengthen and the U.K. economy is weak and
will further weaken you can execute that forecast
using ISE cash settled FX options
• Unlike most markets where you buy something
outright, FX you are always buying one currency
and selling another (currency pair)
15
Features Of ISE FX Options
•
•
•
•
•
•
•
•
Options on exchange rates
U.S. dollar based
.50 strike prices
Premium quoted in U.S. dollars
European Exercise
Cash-settled
Noon Settlement/Option Friday
Noon Buying Rate FRB of NY (or an alternative source, the Reuters
composite rate)
• Available in Conventional Brokerage Account
• Continuous Two-Sides Quotes
• Trading Hours 9:30 – 4:15
16
Initial ISE FX Offerings
• USD/EUR (ticker symbol, EUI):
74.18
(0.7418 x 100)
• USD/GBP (ticker symbol, BPX):
50.43
(0.5043 x 100)
• USD/JPY (ticker symbol, YUK)
119.55
(119.55 x 1) the rate modifier is 1 for JPY
• USD/CAD (ticker symbol, CDD)
113.40
(1.1340 x 100)
17
Proposed ISE FX pairs (prices as of 3-22-07)
•
•
•
•
EUI- 74.18
BPX- 50.43
YUK- 119.55
CDD- 113.40
U.S. Dollar/Euro
U.S. Dollar/British Pound
U.S. Dollar/Japanese Yen
U.S. Dollar/Canadian Dollar
18
Currencies in Dollars over the years
(Swiss Franc will be a future offering)
Currency
1971
1985
1995
2007
Yen
360
263
80
117
Swiss F
3.66
3.45
1.35
1.21
Pound
0.42
0.95
0.62
0.50
Canadian
1.00
1.39
1.35
1.15
19
Currencies in U.S Dollars recently
01
02
03
04
05
06
07 (as
of 3-23-07)
Yen
121 125
115
108
110
116
118
Euro
1.11 1.06 0.88 0.80 0.80 0.79 0.75
Pound
0.69 0.66 0.61 0.54 0.55 0.54 0.50
Canadian
1.54 1.56 1.40 1.30 1.21 1.13 1.16
20
Data vendors format
• Using EUI
OPRA
EUI
Yahoo Finance ^EUI
Bloomberg
EUI<CRNCY>
ILX
EUI
Reuters
.EUI
21
And some of the future offerings…
Australian Dollar
New Zealand Dollar
Swiss Franc
Mexican Peso
Swedish Krona
22
Proposed Future Offerings
Euro/Yen Cross Rate
Euro/Pound Cross Rate
Euro/Franc Cross Rate
23
FX News
• News headline Bernanke boosts dollar,
briefly (WSJ 4-12-07)- The dollar first climbed and then
fell against the euro in a choppy session, but ended the session little
changed from day-earlier numbers. Currency traders focused on
the release of the minutes from the Federal Reserve’s last policy
meeting March 20-21, which showed the Fed remains worried about
inflation and that more rate increases “might prove necessary.” In
response to the report, the dollar immediately jumped higher against
the euro and reached a six-week high intraday high of 119.55 yen
versus the Japanese currency. Higher interest rates generally tend
to lift a currency as it increases returns for investors.
24
FX News (YUK)
• (WSJ) April 12 Meanwhile, Fed Chairman Bernanke
also gave the dollar a short-lived boost during a speech
at NYU when he downplayed the threat of China
substantially reducing its holdings of U.S. assets. Some
dollar bears have said that if a trade war were to develop
between China and the U.S., the Chinese governmentthe world’s second largest holder of U.S Treasurys after
Japan- may retaliate by selling a large chunk of its U.S
holdings. This quite possibly could drive the dollar’s
value down.
25
YUK (USD/Yen)
26
FX news (EUI)
• (WSJ) April 12 The euro rose as expectations for a rate
hike in May or June increased after the European
Central Bank ended its April monetary policy meeting
today. EUI meanwhile dropped to 74.18 as the euro
strengthened against the U.S dollar.
The ECB decided to leave key interest rates unchanged
at 3.75% as expected. ECB Chairman Trichet said in the
post-meeting press conference, interest rates were
accommodative, suggesting the central bank may need
to tighten monetary policy further. He said recent data
showed the economic growth in the euro zone is stable.
27
EUI (USD/Euro)
28
FX News
(CDD)
April 13 (Reuters) - The Canadian dollar, hovering at 4-1/2 month highs
against its U.S. counterpart, is benefiting from higher metals prices
but remains within the range expected by the Bank of Canada,
Governor David Dodge said on Friday.
CDD traded at its lowest level since Nov. 29 at 113.40
"What we've seen is metals, food and energy prices a little stronger
than we might have anticipated at the beginning of the year so the
Canadian dollar has traded up a little bit over this period," Dodge
said on the sidelines of the IMF/World Bank Spring meetings.
"But it's traded roughly in the ranges that we had expected although
a little bit higher. That seems to be largely reflecting the strength in
metals and energy prices."
29
CDD (USD/CD)
30
FX news (BPX)
U.K. Pound Posts Weekly Gain on Prospect of
Two Rate Increases
April 13 (Bloomberg) -- The U.K. pound advanced on the week
against the dollar and yen as traders increased forecasts that the
Bank of England will lift interest rates twice more this year.
BPX traded at 50.43 today, BPX reached the lowest level since
Feb. 27 earlier today
The Bank of England has raised its benchmark rate three times
since August, to 5.25 percent, to tame above-target inflation and
cool the economy.
.
31
BPX (USD/Pound)
32
Product Margin
• Volatility based – set quarterly
• Minimum Margin 2% - 3%
• Ask your brokerage representative
more about the new ISE FX product
and the suitability for you
33
Trading Direction
• Structure Is U.S. Dollar Related
If You Expect The Dollar To Weaken
You Would Buy Puts
If You Expect The Dollar To Strengthen
You Would Buy Calls
34
FX Options
• Think of them as dollar FX index product
Dollar Strong – Buy Calls
Dollar Weak – Buy Puts
35
Option Pricing
• To Price Any Option You Need:
Price Of The Underlying
Strike Price
Cost Of Carry
Time To Expiration
Volatility
36
Option Pricing
• FX Option Pricing
Spot Price
Strike Price
U.S. Rate – Foreign Rate
(Carry Calculation Could Be Negative This is like a stock where the dividend
exceeds the cost of borrowing)
Time to expiration
Volatility
37
Option Pricing
• FX Options
Volatility Is Lower Than Stocks, ETFs
Or Stock Indexes
Volatility Closer To What You Would
Observe In Bonds
Cross Rate Volatilities Are Often 50%
Of The Individual Volatilities
38
Why has there been lower volatility recently in
FX?
• In recent history many of the major economies have not
had major recessions
• Central banks have implemented a more transparent
monetary policy with a focus on price stability
• More flexible exchange rate mechanisms leading to less
currency surprises
• Technology has improved allowing for an increased
expertise in options pricing allowing for a better diffusion
of currency risk among market participants
• But, volatility may increase in the future due to some
unforeseen events
39
Strategies
• Same Core Trading/Hedging Strategies As
Used In Stocks, ETFs and Indexes
Option Buying For Directional Ideas
Option Buying For Genuine Hedgers
Credit Spreads For Income
Spreads For Genuine Hedgers
40
Bearish on the Euro? (which means you are
bullish on the dollar)
• Euro at 77.82 You believe the dollar will strengthen
against the Euro
• One price forecast might be 83.33
• Remember, all the ISE FX option pairs are $ based
• Dollar/Euro, further looking at the forecast: 1 Dollar/1.20
is .8333*100=83.33
• One strategy might be buying the 90 day $78 Call
$1.15
41
EURO (EUI) IDEAS
Buy 78 strike Call at $1.15
+
5
$79.15
0
75
77.82
80
3
5
–
Long Dollar – Long $78 Call
42
Volatility Play Euro Straddle
• You expect a big move in the Euro
• You are unsure in which direction it will
occur
• Buy a straddle Euro @ $77.82
Buy 78 Call
Buy 78 Put
Net Debit
$1.15
$1.40
$2.55
43
Observation
• Put premium may exceed call premium
Why ?
44
Straddle
+
3
0
74
76
78
80
82
3
–
45
Euro Bear Call Spread (Dollar bull
spread)
• Buy 90 Day 76 Call $2.30
• Sell 90 Day 80 Call $. 40
Net Debit $1.90
BE
$77.90
Euro (EUI) 77.82
46
Euro Bull call spread (Dollar bear spread)
• Sell 90 Day 76 Call
$2.30
• Buy 90 Day 80 Call $0.40
Net Credit $1.90
Breakeven 77.90
47
Summary of ISE cash settled FX options
• No underlying delivery concerns
• Options are U.S. dollar relative and premiums
are quoted in U.S. dollar terms
• Trading instrument is intuitive due to being U.S
dollar based, if you are bullish on the U.S dollar
buy calls, if you are bearish buy puts
• .50 strike prices
• European style (no early exercise)
• Noon settlement on expiration day at FRB of NY
rate
48
Summary of ISE cash settled FX options
• Exchange traded and regulated by SEC with all
of the transparency that goes along with the
securities markets
• Available in conventional brokerage accounts
• Similar to equity and index options, investors
can select from the familiar option strategies to
implement their own forecasts for various
currency pairs (calls, puts or using spread
strategies)
49
April 17th quotes for EUI
50
April 17th quotes for BPX
51
April 17th quotes for CDD
52
isefxoptions.com
• Visit the isefxoptions.com website for more
information on this trading instrument
53
International Securities Exchange